Sunday, February 12, 2017

The Death of Dodd-Frank?

Dismissing a half century of successful free market policies is perhaps the worst thing Donald Trump has done to the Republican party. The President’s ignorant beliefs in zero-sum trade policy and massive infrastructure spending repudiates decades of conservative ideology and undermines the American economy. Luckily, while the rest of the Trump administration is marching head on in a radically anti-free market direction, at least one segment hasn’t fallen in line yet. The reliably conservative Vice President Mike Pence has hired one of the libertarian Cato Institute’s top directors as his Chief Economist. Mark Calabria was the Director of Financial Regulation at the Cato Institute until being tapped by the Vice President for this role.

The link is to what clearly is a very rightwing group. Calabria used to work for Senator Richard Shelby and Phil Gramm. He received his degree from George Mason. So what does Calabria think of Dodd-Frank?? Repeal Dodd-Frank? So what’s his reasoning?

After the bank bailouts of 2008, the public was promised “never again.” Unfortunately the same congressional architects of that bailout, Sen. Chris Dodd and Rep. Barney Frank, enacted legislation giving regulators the permanent option of bailouts, as eshrined in the Dodd-Frank Act.

For instance most economists recognize today that many of the New Deal policies implemented in the 1930s slowed the recovery and added to unemployment. Although harder to quantify, an important reason to avoid financial crises is to avoid the policy mistakes that sometimes follow in their aftermath. Accordingly I hope we all share the goal of minimizing both the severity and frequency of financial crises. This is not something we ever want to repeat again ... Key ingredients of this crisis were: exceptionally loose monetary policy ... There is perhaps no issue that drove the passage of the Dodd-Frank Act more than the public perception that certain large institutions enjoyed the backing of the federal government. A situation commonly called “too big to fail” (TBTF). Not by coincidence the first two titles of Dodd-Frank are aimed at addressing the too-big-to-fail status of our largest financial institutions. Here I raise a number of concerns and observations that merit meeting the claim of ending TBTF with considerable skepticism. One reason that debates over TBTF are often so heated is that there is no actual explicit subsidy provided on-budget for such purpose … Section 204, for instance, is quite clear that the Federal Deposit Insurance Corporation (FDIC) can purchase any debt obligation at par (or even above) of a failing institution. If rescuing a creditor at par is not the very definition of TBTF, I’m not sure what is.

Read the entire discussion for yourself as I will concede that I have quoted some of his most right wing comments. But let’s be clear that Dodd-Frank is about a lot more than what to do if a bank declares bankruptcy. I want to return to his most recent discussion as it relates to the issue what we should do to lessen the chances of financial institutions failing in the first place:

It is time for Congress to deliver on the “no bailout” promise. And Rep. Jeb Hensarling has a plan to do just that in his Financial Choice Act. Core to the Choice Act is a move to improve financial stability by increasing bank capital, while reducing reliance on the same regulators who missed the last crisis. While I would have chosen a different level of capital, the Choice Act gets at the fundamental flaw in our financial system: Government guarantees push banks to reduce capital that, unfortunately, leads to excessive leverage and widespread insolvencies whenever asset values (such as houses) decline. Massive leverage still characterizes our banking system, despite the “reforms” in Dodd-Frank. Even ardent supporters of Dodd-Frank, such as economist Larry Summers, have recently concluded it has not made banks safer.

I agree that higher capital requirements would be an improvement but the Goldman Sachs crowd surrounding President Trump are clamoring for lower capital requirements. Maybe Pence and his new chief economist can bring some sanity to this debate. But Dodd-Frank is still about a lot more than capital requirements. Oh wait, Calabria has more to say:

No contributor to the housing boom and bust has been as ignored by Congress as much as the Fed, and its reckless monetary policies in the mid-2000s. Years of negative real rates drove a boom in our property markets. Stanford economist John Taylor has written extensively and persuasively on this topic, yet it remained ignored by Congress. Such reforms are too late to unwind the Fed’s current distortionary policies, but they may moderate future booms and busts.